Giant insurance broker Marsh, battered by regulators, soft market prices and competitors in 2004, plans on dropping thousands of unprofitable U.S. middle and small market accounts as it implements its new business model and ends its reliance upon controversial contingent fees over the next year.
“We are signaling that we are going to be more disciplined and walk away from accounts that are not profitable,” Michael G. Cherkasky, president and chief executive officer of Marsh and McLennan, parent company of Marsh, told analysts.
Cherkasky dismissed rumors that MMC might sell one of its investment or consulting divisions, although he noted that it is planning to spin-off its private equity arm, MMC Capital, to employees.
Marsh is also introducing insurers to standard commissions for placement services. The new upfront charges will be higher than Marsh itself formerly charged but still lower than commissions paid to many competitors, according to the executive. The company hopes the new commission structure will allow Marsh to recover the revenues lost due to a decline in account retention and abandonment of contingent commission income.
Cherkasky said he believes insurance companies will accept the new “transparent” commission rate card in place of the contingent fees that Marsh stopped using last year amid the probe by New York Attorney General Eliot Spitzer.
Marsh earned about $800 million in contingent income in 2004 and another $540 million in 2004 before it halted the practice in October. The company reached a settlement with Spitzer for $850 million.
About half of Marsh’s business in the U.S. is commission-based as opposed to fee-based and could be affected by the commission charges.
Cherkasky said he expects the success of the new business model, exiting of unprofitable accounts and the new commission structure will build over the course of 2005 and then produce “substantial revenue improvement” in 2006 for Marsh.
“In 2006, Marsh will be a stronger, more streamlined company, delivering profitable growth with an operating margin in the upper-teens, and with the opportunity for further margin expansion” the CEO promised.
The larger accounts Marsh is exiting generate about $100 to $150 million in revenue. Some represent accounts that had been profitable only because Marsh used to rely upon contingent income, according to Cherkafsy.
On the smaller accounts being dropped, Marsh believes it cannot make a profit. “It’s not worth the opportunity cost for us to deal with them,” Cherkasky said, adding, “It’s more efficient to exit.” Cherkasky said that Marsh is not currently geared to efficiently service smaller accounts but hopes to get more efficient in the near future.
He also said that Marsh still sees the middle market as “a wonderful opportunity” but only on accounts for which it can get a fair return.
The account downsizing could mean layoffs for employees now assigned to those accounts, part of a planned global 2,500 staff reduction that is expected to save $375 million.
Cherkasky spoke after releasing the latest MMC financial results showing a large fourth quarter loss and announcing a 50 percent cut in the dividend. He stressed that the dividend reduction was to provide cash for 2005 and not an indication of long-term problems.
Cherkasky acknowledged that the loss of some of Marsh’s U.S. accounts did impact the bottom line in 2004 but suggested that retention may be improving in early 2005.
“We expect that when this tempest subsides, we will see more normalized retention rates,” he said.
Noting that four months ago some questioned Marsh & McLennan’s survival because of problems at Marsh’s U.S. operations, Cherkafsy said that is no longer the case. “We have stabilized the company. Today no one questions our stability. It is time to turn the page on crisis management.”
Cherkasky said that he is optimistic about future growth for all of MMC’s units. He noted that its Guy Carpenter (reinsurance brokerage), Mercer (consulting), Kroll (risk consulting and security) and Putnam Investments (investment management) segments are not facing problems like those of the U.S. operations of Marsh.
Asked about speculation that one of these MMC divisions might be sold, Cherkasky directly dismissed those rumors.
“It’s not going to happen,” he declared.
However, MMC Capital, Marsh & McLennan’s private equity firm, will be spun off to employees with Marsh still owning shares in a deal Cherkasky said should close soon.
He downplayed defections among employees, claiming the turnover has not been much more than usual and the effect has been “not material.”
In addition to abandoning contingent fees and introducing standard commissions, Marsh has made other changes to its business model. For one, the company will now provide clients with all quotes and terms as received from insurance companies.
In the fourth quarter, MMC’s consolidated revenues declined 1 percent to $3 billion. After restructuring, regulatory settlements, and related expenses, the company reported a net loss of $676 million in the fourth quarter, or a loss of $1.28 per share. Last year for the same period, the firm reported net income of $375 million, or 69 cents per share.
Full-year consolidated revenues were $12.2 billion, up 5 percent over the prior year. Net income for the full year was $180 million, or earnings per share of $.34.
“Clearly, 2004 was the most difficult year in MMC’s financial history,” said Cherkasky. “We confronted major regulatory issues at both Marsh and Putnam. The settlements we have announced are important steps forward for the company. As a result, we are ready to put these matters behind us and move ahead in 2005 to restore the trust our clients have placed in us and to rebuild shareholder value.”